Wednesday, December 26, 2012

This blog has had two previous discussions
about the causes of the 2007 recession.
The first was a post on the merits of Keynes, Hayek, and Fisher in
providing an answer to the question of what caused the 2007 Great Recession. Despite the popularity of Keynes and Hayek in
popular editorials, the forgotten Fisher provides the best answer. Our country forgot the lessons of Fisher and
encouraged a bubble in real estate that caused the debt-deflation cycle that we have experienced for the last five years.

The second discussion was a post
on Roger Farmer on the role of wealth to create a productive society. Citing Milton Friedman, Farmer provides the
evidence that supports the view that employment tracks positively with wealth. The more wealth we have as a country, the
more employment we have. With more
employment comes more growth and more governmental revenues that provide more
services and reduce deficits and debt.

My own research supports the
Farmer position. However, instead of talking
about wealth, I use the term equity since I
use an accounting view of the economy. When
I look at a statement on the Gross Domestic Product, I see something that is
similar in large terms to a national income statement. And if the country has an income statement, there
must be a balance sheet. I found some
data and built a balance sheet going back sixty years. I analyzed it and saw how equity dropped
seriously in the 2007 recession and in the years following.

Equity is important because it creates the leverage that enables all of us to buy houses and cars and other
things. How many of us postponed a great
many purchases because we wanted to repair our own individual balance sheets
following 2007? Both Richard Koo and
John Taylor termed this effect as a “Balance Sheet Recession” in their
discussions of the Great Recession. If,
from a macro view, the national economy is a composite of our microeconomic behaviors,
then our 2007 recession and recovery should reflect the goals of rebuilding our
balance sheets.

This brings us to the Stimulus
package. If the cure to the recession is
to rebuild our individual balance sheets, then stimulus should enable that to
happen. What did the Stimulus package
do? First, it was a limited series of
tax cuts. Most people used the extra
money to pay down debt, which is good, but it failed to stimulate. In other words, the money was used to rebuild
individual balance sheets. Second, the
Federal government transferred money to the states to reduce program cuts. The Stimulus reduced the number police and
teachers that would have been laid off without the Stimulus. While this is a good thing, it is not stimulative.
In short, this action did not create
growth. The third was a package of road
and infrastructure improvements that took far longer to implement than was
planned, and the growth effect was diluted.
The sum of these parts is that the Stimulus package did not stimulate
very much.

The reason why this happened is
because the policy makers of the time from both parties, including many
economists, just got it wrong. The
administration assumed that the recession was basically the same as before. They did not ask if it was different, and the
administration recommended that the medicine from before would cure it.

The first economists who said otherwise
were Carmen Reinhart and Kenneth Rogoff in their book This Time is Different. They referred to 2007 as a financial recession
but they did not offer a prescription for curing it. We had to wait for people like Roger Farmer
to offer a suggestion.

We should also note that as the
recession continued, people on their own would improve their balance sheets,
which has enabled them to begin buying again.
Once we get back to a national debt/equity leverage typical of the years leading
up to 2007, then the economy will begin to approach pre-2007 growth levels.

If we knew then what some know
now, the recovery would have been different.

Saturday, December 22, 2012

I heard a lecture this semester by Roger Farmer who is the
Chair of the Economics department at the University of California, Los
Angeles. Dr. Farmer is different from
most economists in that he is attempting to address the 2007 recession from a
new perspective. In a previous post I
mentioned that there are the Keynesians, and the Hayekians. There is also Irving Fisher who explained the
1929 depression in terms of a debt-deflation cycle. Dr. Farmer explains Fisher by pointing us to
look at the end result of Fisher, which is wealth. It is wealth that is lost once a
debt-deflation cycle occurs. This is
equity on the balance sheet, and in financial terms, it is that residual value
in our own individual financial structures that allows us to borrow in order to
buy things. It is the basis for our own
personal leverage.

When the 2007 Great Recession hit lots of personal wealth
was wiped out. Some estimates put it as
high as 40%. This restrains consumption
from a Fisher perspective. However,
Farmer makes wealth a more central part of his economic argument. He bases much of his argument on Milton
Friedman, whom he described as a Keynesian.
Friedman stated that consumption is based on wealth and not income, which
is counter to a traditional Keynesian argument that wealth is based on
income. I know what you are thinking,
but I am just reporting what I heard.

Dr. Farmer presented several graphs that brought his
argument into focus. He traced
unemployment through the 1930’s and showed how growth in employment marched
hand in hand with the value of the stock market. He then used this information to build a
model of the relationship between the S&P and unemployment over fifty plus
years. He used the first have of the
years to establish a foundation of data for the model. He then used those years to predict
unemployment from the 1980’s to more recent years, and the model was incredibly
accurate. He demonstrated that wealth
and unemployment move together, and wealth can be used to predict the level of
unemployment.

What are the policy implications of this? Dr. Farmer proposed a solution that could be
received as a “big brother” type of method to stabilize the economy. He proposed that the Federal Reserve establish
an indexed fund of stocks. The term “index
fund” means to buy a set of stocks from the market that mirrors the overall
market. The idea is not to buy a set of
winners over loosers. The fact that the
Federal Reserve would buy an indexed set of stocks to stabilize asset values in
down cycles would also protect employment from moving to the downside in the
proportions that it has in the last five years.

My own personal recommendation is not to tax capital,
because taxing capital would retard its growth.
If you want employment to grow, wealth should grow.

Dr. Farmer has a little book that I recommend to anyone who
wants to understand the economy, but who has not the time or the patience to
suffer through a college course on the subject.
The book is How the Economy Works
and it is available on most bookseller web sites. Dr. Farmer’s own web site with his
mathematically based technical working papers is linked here as well.

The idea that wealth relates closely to unemployment is not
a new idea, but Dr. Farmer has been able to put together persuasive evidence
that the relationship is real.

About Me

Who am I? I am a guy who has had a number of jobs in both the private and public sectors, most in finance, planning, and management. My educational background includes studies in public administration, public policy, finance and accounting, computer systems, mathematics, and recently, economics. I grew up as a conservative Republican who loved Nixon up until he broke my heart. I have also liked some Democrats such as John Kennedy and Birch Baye. This is my first attempt ever at trying to be public with my opinion. I would prefer spending my time taking classes, learning new things, enjoying close relationships, and looking forward. But if more of us from the old middle would be more vocal, perhaps our politics will change. My educational background includes a PhD in Public Administration with emphases in public finance and public policy, a Masters of Accounting, and other degrees. My experience includes project management positions with a defense company, a computer company, and a transportation company. I have also taught at several universities and colleges in two states.